By Christine Harper
(Bloomberg Businessweek) — Paul Volcker was feeling a bit forgotten in late 2017 when he started working on his memoir, which I was helping him write. Inflation was no longer feared, exchange-rate crises weren’t big news, and his longtime campaign to improve public administration seemed more quixotic than ever. So the 90-year-old former leader of the Federal Reserve started his book with a self-deprecating joke about a wise old parrot known as “the chairman,” and insisted the title should be The Wise Old Parrot Speaks.
Understandably, the publisher’s marketing staff wasn’t keen on that. Eventually, I threw out the phrase “sustained commitment,” which I’d spotted in some old Fed minutes. Volcker’s face lit up as he translated it into plain language: “Keeping at it!” We had our title.
___STEADY_PAYWALL___Everyone wants to know if, and how soon, the US Federal Reserve can bring inflation under control. Chair Jerome Powell, keen to show he’s on the case, has said the Fed will “keep at it” until the job is done. That’s led some to draw a connection to Keeping At It by Volcker, America’s most famous inflation fighter. Although he is celebrated for conquering inflation, few remember how tough the fight was and how much pain the economy endured. To see the challenge ahead for Powell, it’s useful to revisit Volcker’s bumpy path to victory.
When President Jimmy Carter appointed Volcker Fed chair in August 1979, the central bank was also facing a crisis. Volcker had watched his two predecessors, Arthur Burns and Bill Miller, lose all credibility by failing to deal effectively with rising prices, allowing an inflationary mentality to become entrenched among the public.
Ten days into Volcker’s term, the Fed’s policy arm, the Federal Open Market Committee, raised the discount rate by half a percentage point, to a record 10.5%, and a month later it lifted the rate again. But the vote on the second increase was 4-3. The markets interpreted the split on the committee as a sign that Volcker was losing support and that the Fed would soon lose its taste for raising rates. The Associated Press quoted Lawrence Kudlow, then an economist at Bear Stearns—more recently an economic adviser to former President Donald Trump—saying that the split vote “suggests circumstantially that future policy adjustments will be of a timid nature.”
Markets seemed to agree. The dollar fell, and the price of gold surged—both bets that more inflation was to come. At the end of September, Volcker traveled to a conference in Belgrade, where he watched Burns give a speech titled “The Anguish of Central Banking” declaring that central banks couldn’t adopt the tough policies necessary to fight inflation because of social and political opposition. Volcker returned to Washington intent on proving Burns wrong.
To help make his point, he turned to monetarism, the theory espoused by economist Milton Friedman, who argued that central banks should control inflation by curbing the growth in the supply of money in the economy, rather than by using interest rates as levers. As a young economist at the New York Fed, Volcker and many of his colleagues viewed such a mechanistic approach as naive and misguided.
But in letters that he wrote upon becoming Fed chairman, including one to Friedman, Volcker had clearly come around to seeing monetarism as a potentially useful tool. Its main downside—that it tied policymakers’ hands—could be an upside if it served to assure the markets that the Fed wouldn’t, indeed couldn’t, back down.
On the afternoon of Oct. 6, 1979, addressing reporters at a hastily called press conference, later dubbed the “Saturday Night Special,” Volcker unveiled the Fed’s new strategy: It would focus on restricting the amount of money in circulation, no matter what effect that would have on interest rates. In other words, the Fed would quell inflation by cutting the supply of money available to pay for goods and services (the quantity) instead of simply raising the price of money (interest rates).
The market reaction was swift. Stocks fell, short-term and long-term interest rates surged to record levels, and commercial banks raised their minimum rates on corporate loans by a full percentage point, to 14.5%. In a front-page New York Times story on Oct. 10, an unidentified head of one major corporate bond trading desk was quoted as saying, “I can’t remember another trading day when every market got smashed so badly.” And that was just the beginning. Eventually average rates on 30-year mortgages would surpass 18%.
The soaring rates infuriated farmers, who rely on borrowed money to fund their plantings. They blockaded the Fed’s Washington headquarters with tractors. Homebuilders mailed Volcker two-by-fours inscribed with angry messages. Business leaders doubted that the approach would succeed in quelling inflation, which was running above 11% in 1979 and climbed to 13% in 1980. Volcker recalled meeting with a group of executives, one of whom told him he’d just agreed to increase his workers’ pay by 13% for each of the next three years.
Carter attempted to help, with mixed results. In March 1980 he announced a series of spending cuts to balance the budget. That was welcome. What Volcker and his Fed colleagues didn’t love—but felt forced to publicly endorse—was the decision to impose “credit controls,” essentially setting some limits on how much money banks could lend and people could borrow. Americans, eager to show their support, cut up their credit cards and mailed them to the White House. The effect, Volcker later wrote in his memoir, was a sudden drop in the money supply and an “artificial” recession. The Fed was forced to make a brief U-turn, easing access to money and credit, before resuming its inflation fight in the autumn of 1980.
In mid-1981 the economy went into another recession, the worst since the Great Depression. The unemployment rate climbed to 11%. Criticism of the Fed intensified. The Fed required the 6-foot-7-inch Volcker to agree to “personal security escort protection”: a bodyguard.
A year later an armed man was arrested after entering the Fed building and threatening to take the board hostage. Screaming protesters occasionally interrupted Volcker’s speeches—and once let rats loose in the audience. Some members of Congress threatened Volcker with impeachment.
In his memoir, Volcker wrote that the monetarist approach helped him and his Fed colleagues resist the temptation to give in to critics because they were “lashed to the mast.”
“I suppose if some Delphic oracle had whispered in my ear that our policy would result in interest rates of 20 percent or more, I might have packed my bags and headed home,” he wrote. “But that option wasn’t open. We had a message to deliver, a message to the public and to ourselves.”
By the summer of 1982, the inflation rate had fallen back into the single digits. Volcker, worried about the risks that a potential debt default by Mexico and other Latin American countries posed to US banks that had loaned billions of dollars to governments in the region, scrapped his brief flirtation with monetarism. The Fed spent the next few years cleaning up a series of financial catastrophes that resulted from its tight-money policy, including the restructuring of Latin American debts, after so many institutions had become overly indebted during the preceding loose-money era.
Today, with its tough talk and a series of supersize interest rate hikes, Powell’s Fed seems to be trying to show that it, too, is prepared to do whatever is necessary to bring down inflation. But the legend of Volcker, the superhero inflation fighter, often overlooks just how costly that battle was. Years later, in his conversations with me as I helped him write his memoir, Volcker still wrestled with the question of whether he could have done anything differently and caused less harm to American workers and the economy.
“Did I realize at the time how high interest rates might go before we could claim success? No,” Volcker wrote in his memoir. “From today’s vantage point, was there a better path? Not to my knowledge—not then or now.”
The real test for Powell and his colleagues will be whether they can also persist if the economy and the financial system start to show serious signs of strain. Volcker told me he supported Powell’s nomination as Fed chairman because he liked that his background was in the financial industry and the Treasury Department—experience that Volcker believed would help him better understand the practical effects of monetary policies. I suspect that Volcker would be urging Powell to “keep at it” because the alternative is to lose the credibility that Volcker fought so hard to restore.
